View Points April 11, 2014

Guide to Understanding In-Plan Guaranteed Income Solutions

Today, the retirement plan industry is placing greater emphasis on getting participants to and through retirement successfully.
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More than ever before, employer-sponsored retirement plans are offering guaranteed income solutions to help meet this need. It’s important for advisers and consultants to understand the proliferation of guaranteed income solutions and how they can help savers achieve a better retirement outcome.

Securities-based Solutions

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Securities-based solutions, such as managed payout strategies and retirement income mutual funds, can help participants achieve retirement income and provide access to upside potential in the market (as well as its downside risk), but without a guarantee that the money will last for a participant’s lifetime. These strategies are designed to provide a steady stream of retirement income and allow retirees access to their money during their lifetime while leaving an opportunity for a legacy for their heirs in the event of death. Managed payout solutions emphasize the decumulation phase—they make periodic distributions that can go up or down based on market performance at a specified rate and can have different objectives and risks associated with them.

Traditional Insurance Annuity Solutions

Some traditional insurance annuity solutions provide a guarantee of lifetime income that avoids market losses, but restricts the opportunity to capture market gains since the rate of return is guaranteed and fixed. These annuity solutions are used both in and outside of retirement plans. The principal advantage of traditional fixed annuity contracts is that they guarantee income payments for the life of the participant and/or his or her spouse. Unless a “period certain” annuity is utilized, a participant generally relinquishes access to the market or account value thereby limiting the ability for fixed annuities to be passed on to heirs or estates. 

Blended Solutions

Guaranteed withdrawal benefits (GWB) are often combined, or “hybrid” solutions, that consist of a mutual fund, such as a balanced or target-date fund (or similar diversified investment vehicle), and a guaranteed withdrawal benefit feature, which is issued by an insurance company. The contractual provisions include income for life, access to assets during the accumulation period as well as the payment or income period, and protection of guaranteed income in down markets, enabling savers to participate in rising markets. Participants are able to maintain a higher equity exposure in their portfolio due to the protection and guarantees provided, promoting better asset allocations for participants nearing retirement.  Participants retain ownership of and access to their accounts and can leave any remaining balance to their heirs. These offerings can be more expensive than other non-insured solutions.

While all of the solutions provide distinct advantages and disadvantages to savers, an understanding of the value of in-plan guarantees can help advisers and consultants stand apart in today’s retirement landscape.

Here are some things to consider when recommending an in-plan guarantee to employers:

What are the key benefits of in-plan guarantee solutions for plan sponsors?

  • Plan sponsors may be able to offer in-plan solutions at a lower cost to participants because the solutions are institutionally priced.
  • These solutions can provide a competitive retirement benefit for employers to help recruit and retain top talent.
  • Plan sponsors can help transition employees into retirement by offering an in-plan guarantee solution. Participants closer to retirement may feel the need to work longer if they are uncertain that their retirement income will meet their expenses. This can lead to fewer opportunities for advancement for employees who are earlier in their career. An in-plan guarantee may help participants closer to retirement leave the workforce when they are ready and create career opportunities for high potential employees to fill these positions.
  • In-plan guarantees can be simple to integrate with existing target date or asset allocation solutions.
  • Employers that had a defined benefit plan in the past can incorporate some of the same benefits like income distribution into their defined contribution program.
  • The solutions may be appealing for sponsors concerned with the benefit adequacy and unsustainability of withdrawal rates for plan participants by offering guaranteed payments for the lives of their participants and the participant’s spouse.

  

What are some fiduciary considerations for in-plan guarantees?

A plan sponsor has fiduciary responsibility for the selection, review and monitoring of any investments within their retirement plan, including in-plan guaranteed products. Some recordkeepers, providers and intermediaries provide tools that support plan fiduciaries that can help a sponsor readily apply the fiduciary process to in-plan guarantees. These tools make the fiduciary evaluation much easier for plan sponsors. Some of the resources also include tips about how to evaluate the financial strength and claims-paying ability of an insurance company.

What’s the future for in-plan guarantee solutions?

The Department of Labor (DOL) is working on a proposed regulation that would require monthly income projections to be included on participant quarterly benefit statements. Many providers already offer this service. DOL indicated it will release a proposal to amend its “safe harbor” rules for fiduciaries that make annuities available as distribution options from a defined contribution plan.  Fiduciaries often tend to seek to satisfy a safe harbor when one is available.  If the new regulation is easier to comply with, it could act as a regulatory catalyst to promote further adoption of guaranteed income solutions.

In-plan guaranteed income investments may not be suitable for every plan. Advisers should evaluate a plan sponsor’s retirement plan goals to determine the solution that makes the most sense for its participant base. By understanding the need for and move towards guaranteed income solutions, intermediaries have the opportunity to introduce their clients to a savings vehicle that can help ensure savers get to and through retirement with confidence.   

Lincoln Financial Group is the marketing name for Lincoln National Corporate and its affiliates.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.

The Markets April 10, 2014

Is LDI Feasible for DC Participants?

Defined contribution (DC) plans are increasingly adopting practices similar to defined benefit (DB) plans to improve participant outcomes, including automatic enrollment and “do-it-for-me” investments.
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One current DB trend is liability-driven investing (LDI), in an attempt to match assets to future benefit obligations. Is there a way for DC plans to make use of LDI?

The shift in focus for DC participants from accumulation of assets to understanding how those assets can produce reliable income in retirement has been a growing topic for the past five to 10 years, says Bob Schmidt, manager of the Brandes Institute. “The aging Baby Boomer population is putting more emphasis on the issue, with 19,000 turning 65 every day,” he tells PLANADVSIER. “How do you generate income for these folks?” But how to guarantee income within a DC plan is still uncertain.

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Schmidt points out it can be very hard for people to conceptualize the best way to handle an accumulation of retirement assets. “People get used to receiving a paycheck once or twice a month,” he says. “Then suddenly: ‘Here’s your lump sum. Manage that for the rest of your life.’ “

In theory, LDI makes tremendous sense, Schmidt says, since the strategy is used as a way to balance assets against future needs. “That said, there are some practical issues that make it tough to implement,” he notes. First, it’s very difficult for individuals to accurately forecast how much money they will actually need in 15, 20, 30 or 40 years.

Schmidt points out a number of macro assumptions to consider, such as inflation or how long someone’s lifespan might be, which cannot be predicted with certainty. People also need to factor in housing costs, possible medical needs (another area that is difficult to forecast accurately), or the wish to share money with children or grandchildren to help with college tuition or a home purchase. “An unforeseen medical need or family issue may significantly alter income needs in retirement,” he says.

“You don’t have the pooling of assets and the pooling of longevity risks” in a DC plan, Schmidt points out, so it is possible a hybrid approach that works along a combination of factors, is called for. “Some kind of income security and some kind of asset maximization,” he says. “You might have a portion of assets in an immediate annuity and the remaining in stock, corporate bonds, real estate and other asset classes. So you’re looking for inflation-fighting protection of capital appreciation investments like equities, and complementing it with some kind of income-producing product, like an annuity.”

Schmidt says the biggest concern with using DC investment options to create an LDI strategy is cost. Combining strategies is best, he feels, because it helps balance pros and cons. “You can get income security now, but with interest rates at record lows, you’re going to pay a lot,” he says. “Thinking interest rates will remain low is not a realistic assumption. If they go up, people will leave a lot of money on the table. If interest rates were at 7% or 8% that would change the discussion quite a bit. But that’s not the case.”

As the purpose of LDI is matching assets with liabilities, using it in a DC plan would mean taking out money at pretty low rates, explains Bruce Grantier, the now-retired managing director of pension assets at Scotiabank. “Structurally, it would work,” he says. “But practically? Now is not a great time.”

Grantier says plan sponsors can consider a fixed-income oriented fund with a long duration--or whatever duration is appropriate for when participants retire. “The duration, based on life expectancy, is like a long bond,” he says. “You could have a target-date LDI. If you retire at 65 and are going to live another 20 to 25 years, you’d move from the equities to more fixed income.”

Bond options within a target-date fund (TDF) are one possibility for plan sponsors to consider, Grantier says. This approach is used for a mix of bonds and equities, but it can be used to lock in retirement income. Alternatively, an all-bond fund could be used.

Schmidt is a believer in the stock market for long-term gains. Annuities are the obvious product to generate a guaranteed stream of income in retirement, but he feels there are other opportunities that will continue to generate wealth and produce income, like equities. “These should be a core component to get you not just to retirement, but through it as well,” Schmidt says.

Investors became jittery as the stock and real estate markets pulled back in 2008 and 2009, he notes, and became less willing to depend on them. “People were looking too much at the short term,” he says. “In a lot of places, the real estate market has bounced back. The stock market has come back, and exposure to appreciating assets like equities is a great source for retirement plans.”

Some investors may want to limit price volatility of plan assets in the short term, Schmidt says. “Some may be concerned with mark-to-market accounting rules and funding levels,” he says. “But these types of short-term considerations may drive investment decisions that are at odds with longer-term needs.” 

An example in the context of LDI would be that investors struggle with the best way to build a portfolio of assets to meet their liability needs decades from now.  “In the short term, stock prices can be volatile—and a reluctance to accept these inevitable bouts of volatility may prompt investors to load up on bonds and minimize exposure to equities,” Schmidt says. “But we think that’s the wrong approach. We remain convinced that stocks represent one of the best asset classes to help investors reach their long-term goals and deserve a seat at the table, even within an LDI framework.”

If LDI as a concept helps people to focus on the income they’re going to need in retirement, Schmidt feels that is terrific. “That is the goal of retirement planning,” he points out.

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